PRICE DISCRIMINATION

Price discrimination is the practice of selling the same good at different prices to different customers, even though the costs for producing for the two customers are the same.

PRICE DISCRIMINATION Price discrimination is not possible when a good is sold in a competitive market since there are many firms all selling at the market price. In order to price discriminate, the firm must have some market power. Two important effects of price discrimination: –It can increase the monopolists profits. –It can reduce deadweight loss.

Welfare with and without Price Discrimination Copyright © 2004 South-Western Profit Monopolist with Single Price Price 0 Quantity Deadweight loss Demand Marginal revenue Consumer surplus Quantity sold Monopoly price Marginal cost

Forms of Price Discrimination Perfect Price Discrimination –Charging each customer the exact price they are willing to pay Extracts all of the consumer surplus to producers Quantity Discounts –Changing lower prices for additional units of consumption Extracts a portion of consumer surplus Consumer Differentiation –Charging different customers different prices based on consumer characteristics Extracts a portion of consumer surplus

Welfare with and without Price Discrimination Copyright © 2004 South-Western Profit Monopolist with Perfect Price Discrimination Price 0 Quantity Demand Marginal cost Quantity sold

PRICE DISCRIMINATION Examples of Price Discrimination –Movie tickets –Airline prices –Discount coupons –Financial aid –Quantity discounts – bulk retailers

Third-Degree Price Discrimination P 1 = Q 1 and MR 1 = Q 1 MC = 2 P 2 = Q 2 and MR 2 = Q 2 MR 1 = MC = 2 MR 2 = MC = 2 MR 1 = Q 1 = 2 Q 1 = 50 MR 2 = Q 2 = 2 Q 2 = 40 P 2 = (40) = $4P 1 = (50) = $7

Third-Degree Price Discrimination

International Price Discrimination Persistent Dumping Predatory Dumping –Temporary sale at or below cost –Designed to bankrupt competitors –Trade restrictions apply Sporadic Dumping –Occasional sale of surplus output

Price Discrimination Question Marshall Field, a large department store in Chicago, sells suitcases. It will give you $30 if you trade-in and old suitcase to get a new one. They throw the old suitcases away. Why do they cut the price up to $30 for the owner of old suitcases but not the other customers? Many motels and restaurants have signs that say Discounts for Senior Citizens. They advertise that they wish to honor the elderly. Is that why they grant them a lower price?

Price Discrimination Question At most restaurants in the U.S. there are separate menus for lunch and for dinner. At lunch, meals are about half the price of meals at dinner that are very nearly the same (usually a trivial difference in food cost). Why is there such price discrimination? Does it hurt consumers? U.S. residents who travel to Canada and Mexico, which may just be a trip of a few miles, often report that the same products are being sold at lower prices in those countries. Why would producers sell for less?

Coupon Question When Disney sells a new DVDs of a movies, it often has a mail-in coupon that allows the customer to get a rebate (price discount). On a $20 DVD, there may be a $5 mail-in coupon. These are expensive to process, so why does Disney not just sell the movies for $15?

Additional Pricing Practices Two-Part Tariff Tying Bundling Prestige Pricing Price Lining Skimming Value Pricing